Web3, blockchain, and decentralized finance (DeFi) technologies, with their famously libertarian users, seem like the last places you’d expect to see a credit-scoring system. But money talks, even in a DeFi world.
If you understand a traditional credit score, you understand the point of a web3 credit score: to ascertain trustworthiness of individuals trying to transact on blockchains. Their basic scheme of operation isn’t too dissimilar from centralized finance credit scores either.
Where web3 credit scores differ from their analog ancestor is in how they define identity, and how easy it may be to fool them. Web3, cryptocurrency, and DeFi are all about anonymity, which makes it tough to see how credit scoring – a necessarily intrusive concept – can eliminate rampant web3 fraud without upsetting many of its advocates.
But what is a DeFi credit score?
Credit scores in the physical world use a variety of metrics to arrive at a picture of an individual’s financial state – payment history, length of credit, debt-to-income ratios, and other data points are part of how banks and lenders gain an understanding of the risk a person presents.
Web3 credit scores would ostensibly do the same thing, but for decentralized financial systems.
There’s a lot of overlap between web3 credit score companies’ methods, which generally involve linking one or more wallets to the company’s system and letting an algorithm dig through the wallet’s on-chain (and sometimes off-chain) history to build a picture of its owner.
With a score established, the various DeFi credit agencies issue NFTs that serve as a token of creditworthiness. Those NFTs can be attached to any blockchain transaction on a system that supports smart contracts, like Ethereum, and could theoretically be used in place of collateral, which is commonly how DeFi transactions and loans are backed.
The problem with DeFi credit: Identity
It could be argued that the reason why credit scores work is because of their centrality. Banks and lenders report to whichever bureaus handle credit ratings in a particular country, and those bureaus in turn are able to keep an (ideally) accurate record of how borrowers behave.
Not so with decentralized credit scores, and that appears to be a serious problem, DeFi researcher Chris Blec pointed out in a Twitter exchange with Julian Gay, CEO of Cred Protocol, a company developing a web3 credit scoring system.
Discussing the use of multiple wallets, Blec said such users may be expecting a higher degree of privacy. In other words, what’s to stop them from simply not linking additional wallets in order to compartmentalize their online…
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